Mark Thoma over at The Economist's View last week wrote a short essay that was long on good sense. He commented on a Simon Johnson post that in turn thrashed a Chamber of Commerce attack on the proposed consumer protection agency as bad for small business. Knowing that tangled thread isn't really necessary to appreciate Thoma's little piece. His post, "Markets are Not Magic," works the middle ground between those who would dismantle markets as threats to civilization and those who would free them through deregulation. Thoma makes the eminent but not-heard-nearly-enough argument that intelligent regulation is necessary for markets to function properly and that well-ordered, sensibly supervised markets are marvelous mechanisms for allocating resources and creating wealth and efficiency.
Thoma is particularly good at drawing distinctions, many of which have been trampled in the stampede to free markets, then beaten to a pulp in the rush back to -- well, who knows what. "There is nothing special about markets per se -- they can perform very badly in some circumstances," he writes. "It is competitive markets that are magic, though even then we have to remember that markets have no concern whatsoever with equity, only efficiency, and sometimes equity can be an overriding concern." This is hardly a revelation, but it is a breath of fresh air. So is Thoma's recitation of the special conditions that must be present for markets "to work their magic efficiency," from full information being available to participants to the presence of enough buyers and sellers to the availability of free entry and exit.
Thoma's markets are not some part of nature, or some gift from God, but institutions designed by men to perform certain limited goals. They are not useful for everything, just as some measure of "efficiency" can't be beneficially applied to large swaths of human experience.
Thoma's post implies how relatively little attention markets themselves have received in the backwash of the crisis. So much of the commentary on the crisis focuses in on the banks, Wall Street or finance. Matt Taibbi blames Goldman, Sachs & Co. for everything. Any number of others pillory Ken Lewis, Dick Fuld, Alan Greenspan, Henry Paulson. Others blame bonuses, greed, malfeasance. There's some degree of equity and truth (though it varies) in all those charges: After all, individuals and institutions were responsible for stockpiling risky assets that eventually blew up -- or for allowing those assets to accumulate and pool. Beyond vague gestures about the demise of the efficient market hypothesis, there has been much less commentary on how these enormous, deep and often global markets grew, proliferated and made an expansionary, occasionally hegemonic, finance sector possible. True, Lord Turner's proposal for a Tobin tax on financial transactions might have effectively put some markets on a diet, depending on the market and the tax bite. But after a few weeks of discussion, that kind of remedy seems to be going nowhere, and there are few proposed rules and regulations, with the exception of moving OTC derivatives to exchanges and clearinghouses, that would roll back the proliferation and ubiquity of any financial markets, particularly of the more speculative variety.
Put it another way: For all the damage from the crisis, the exposure of ordinary folks -- Main Streeters -- to the financial markets looks to remain at best unchanged and at worst more extensive than when the crisis began. The crisis has further weakened an already fading defined benefit pension system, further entrenched (despite the huge losses) defined contribution plans. Health care reform, as Thoma suggests, involves a variety of market mechanisms. And the response to volatile markets is not plain-vanilla financial products, but more complex products that use market mechanisms to cope with uncertainty. Under some conditions, plain vanilla can be as ugly as adjustable-rate mortgages.
Thoma's careful delineation of conditions for optimal markets raises other questions, not just for regulators but also for politicians and policymakers. In what circumstances can these conditions be met? Where is the functional line between, say, equity and efficiency? Who should play in these markets and who should be protected from them? Does the notion of a level playing field make sense in these deep, risky, complex markets? How do such pervasive markets reshape the economy and our politics?
Right now, these are not burning questions, which suggests that we are sidestepping anything that threatens to limit, undermine or significantly change our markets, and our relationship to these markets. It's a lot like the investing world after the hammering absorbed by the efficient market hypothesis. Investors may no longer put their full faith and credit into rational markets, but, given no practical alternatives, they continue to invest as if nothing had changed. Markets, market efficiency and the primacy of economics over all other considerations seems to have absorbed so much intellectual oxygen over the past few decades that we literally can't imagine an alternative. That may change, but it will be slow and probably painful. Meanwhile, we depend on folks like Thoma to at least remind us what markets can and cannot do.